United States: How Do Companies Cope With Social Risk?

How do companies cope with social risk? In "Blindsided by Social Risk—How Do Companies Survive a Storm of Their Own Making?" from the Rock Center for Corporate Governance at Stanford, the authors look at "social risk," essentially, reputational risk that can impair a company's social capital and, in some cases, its performance. These risks can arise from a variety of circumstances—a damaging statement or action by a company representative (a CEO, a board member, an employee) that triggers an adverse reaction from customers, employees, regulators or the public; a troubling interaction with a company's services or a product name considered offensive; a damaging event at a competitor that fuels a broader inquiry across the industry. In these types of cases, "media attention (social or traditional) amplifies the impact, sparking a backlash that extends well beyond the directly affected parties." Because social risks can be more nebulous and unpredictable than traditional operating or financial risks—and the extent of potential damage more difficult to gauge—companies may find it especially challenging to anticipate, prepare for and guard against them. Yet, the paper asserts, "so called 'social risk' can be just as material as any operating, financial, or strategic disruption." What can companies and boards do to protect against these types of risk events or mitigate their impact?

Among the examples of social risk events cited in the paper are video of a passenger being forcibly ejected from an overbooked airline flight and CEO criticism of the NFL's handling of player protests. Both of these events were amplified by media attention, leading to significant social damage. In one case, the company revised its overbooking policies as a result; in the other case, sales declined and the CEO resigned. Other examples involve a kind of contagious social risk, such as allegations of employee harassment that "encourage deeper scrutiny of other workplace practices at the firm or across firms," or a company's public position on a social issue that "invites inquiry into the stance of peer organizations on the same issue."

The paper identifies a number of reasons for the recent intensification of social risk, including the heated political climate and the proliferation of various forms of media, which have fueled a "heightened sensitivity to issues that might previously have been tolerated or ignored." In addition, companies may be experiencing more social risk in light of the increased tendency of CEOs to make public statements about burning social issues and, perhaps related to that tendency, a shift in the view of companies, investors and the public about the "purpose" of a corporation—away from pure shareholder value maximization and in favor of stakeholder capitalism. (See this PubCo post discussing the Business Roundtable's adoption of a new definition of corporate purpose providing for a "modern standard for corporate responsibility" that involves a commitment to all stakeholders.)

The authors cite research that shows the types of damage that can result from social risk, including damage to the "engagement, morale, and productivity of a company's workforce," as well as financial performance; a prior study from the Rock Center demonstrated that "members of the public are more likely to remember corporate stances they disagree with rather than those they agree with, and they are more likely to stop using a company's product because of a position they disagree with rather than start using one because of a stance they agree with." In some cases, a company's existing goodwill can provide protection, while in others, it leads to a sense of betrayal. Another study, highlighting the difficulty of predicting public responses, surprisingly showed that "proactive reputation management strategies can actually increase financial damage by signaling to the market that a problem is worse than it is." Another study showed that, while reputational risk is high on the list of board concerns, "a third of boards (32 percent) have few or no plans to address reputational risk."

In the first sample, consisting of 222 social risk events occurring during August 2019, the authors were surprised by the variety of incidents that attracted public attention, including incidents relating to customer interactions, marketing decisions (such as branding and product names) and product issues (45%); corporate policies, employment and workplace practices (28%); and social, environmental or political issues (27%). In 55% of the instances, the risk events were triggered by internal corporate decisions or employee actions, such as a corporate policy, product or branding decision or other action taken by a company representative; and 19% were the result of employee protests or employment-related issues. In 26% of the events, the catalyst was "external scrutiny that the company did not invite through deliberate actions or choices." The extent of media coverage tended to be highly variable, depending on the nature of the social risk event. In addition, the authors observed, significant events "frequently reemerge in some new way to further damage the company's reputation. They also transfer across companies as public attention looks for analogous occurrences at unrelated firms." A third of events fell into the repeat category.

In terms of impact on performance, in the sample, the authors found a "market-adjusted" median decline in stock price of 0.4% over the first three days after the first publication identifying the issue. In addition, the authors reported that the company issued a public statement in 55% of the instances, initiated an investigation in 9% and terminated a senior executive or manager in 15% of the instances. Formal lawsuits, regulatory scrutiny, and SEC disclosure were more rare.

The authors also looked at a second sample—this time of 143 race-related social risk events occurring between May 25 and June 25, 2020. These events also involved a variety of incidents, including marketing or other policy changes (30%), employee-related initiatives or protests (25%), product branding decisions (14%), employee terminations (7%), business disruption or cancellations (5%), and other issues, initiatives or boycotts (19%). The authors observe that 75% of the media coverage was negative in tone, involving allegations of racism, products or policies deemed racist or discriminatory, or terminations for allegedly racist behavior or for condoning racism. Only 25% of the coverage involved positive news, such as policies to promote equality or awareness, or donations or investments to promote positive outcomes; however, companies were slow to take these positive actions, with most occurring in the second half of the measurement period. The authors were struck by the number of branding decisions made or considered in such a short time, "changing the names of products whose brands in some cases extended back for over a century. This surprising outcome underscores the severity of social risk."

The authors provided the following recommendations from consultant Marketing Scenario Analytica to help boards and CEOs prepare for, manage and mitigate social risk:

• "Use knowledge of the past to inform future plans. Companies can accomplish this by examining social risk events that have impacted peer groups and related industries. By developing a comprehensive history of social risk, management and boards can understand the variety of potential risks [a company] faces and evaluate patterns in how risk events have evolved over time.
• Conduct scenario planning to identify the highest likelihood risk events. This involves identifying events that are most likely to manifest themselves based on the company's industry, profile, and vulnerabilities. Quantify the severity by looking at the potential impact on brand, product, suppliers, employees, and overall reputation.
• Prepare responses and identify the resources necessary to prevent or mitigate the highest likelihood risks. Consider both preventative and responsive measures, over both short-term and long-term time horizons, and develop resources, programs, and policies to protect the company on an ongoing bases."

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